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Australian dividends: The gift that keeps on giving

Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

The big miners may have slashed their dividends, but for Australian share investors the local market still offers attractive income returns despite recent volatility.

According to BetaShares, dividends have been the "quiet achiever" of the Australian bourse, making a significant contribution to the market's overall return. In the 12 years to the end of 2015, the compound annualised return for the benchmark S&P/ASX 200 Index was 8.8 per cent, but the price index returned just 3.2 per cent, implying that dividends made up two-thirds of total returns.

Boards have been reluctant to deny shareholders their promised returns, leading to dividends being far less volatile than share prices. Share price returns have seen large fluctuations in recent times, including a near 43 per cent decline in the year to November 2008 and an almost 39 per cent gain in the year to February 2010, with a standard deviation in rolling 12-month price returns of 17 per cent a year for the S&P/ASX 200 during the 12 years to the end of 2015.

In contrast, the standard deviation in rolling 12-month dividend returns over the same period was only 0.7 per cent a year. The worst result was a 2.7 per cent gain in the 2008 calendar year, with the best performance a 6.2 per cent rise in 2009.

During 2015, the grossed-up dividend return after accounting for franking credits amounted to 6.5 per cent--more than three times the central bank's official cash rate of 2 per cent.

Australia's dividend imputation system has been described as "one of the seven wonders of the world," and despite threatened moves in 2015 to abolish it, remains a major reason behind investors' love for dividends.

Under the system, investors who receive a dividend are only taxed the difference between the company tax rate (currently 30 per cent) and their own marginal tax rate, while any associated imputation or franking credits are fully refundable.

As a result, investing in shares that pay a fully franked dividend can be a highly tax-effective investment strategy, particularly for higher income earners and also self-managed super fund investors.

Top dividend stocks

Morningstar's latest "Best Stock Ideas" report points to a number of high dividend paying stocks with potential for further gains in market value. These include Westpac Banking Corporation (WBC), with a forecast dividend yield of 6.6 per cent which "grosses up" to 9.4 per cent, while rival Commonwealth Bank of Australia (CBA) has a 6 per cent forecast yield.

Both top four banks have a wide moat rating from Morningstar, with CBA seen as the preferred Australian major bank exposure.